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August 31, 1978


The opinion of the court was delivered by: PARKER


This opinion covers the final act in a civil proceeding brought by the Securities and Exchange Commission (Commission or SEC) seeking injunctive sanctions against numerous defendants as a result of their participation in alleged securities laws violations relating to the National Student Marketing Corporation (NSMC) securities fraud scheme. *fn1" The original defendants included the corporation and certain of its officers and directors; the accounting firm of Peat, Marwick, Mitchell & Co. (Peat Marwick) and two of its partners; several officers and directors of Interstate National Corporation (Interstate); the law firm of White & Case and one of its partners; and the law firm of Lord, Bissell & Brook (LBB) and two of its partners. The majority of these defendants are not now before the Court. As discovery progressed during the pre-trial stages of this litigation, NSMC and other principal defendants consented to the entry of final judgments of permanent injunction or otherwise reached a resolution of the charges against them. *fn2" The only defendants remaining are Lord, Bissell & Brook; its two partners, Max E. Meyer and Louis F. Schauer; and Cameron Brown, a former president and director of Interstate, and presently a director of and consultant to NSMC.

 The focal point of the Commission's charges against these defendants is the corporate merger of Interstate with NSMC on October 31, 1969. The principal question presented is whether the defendants violated or aided and abetted the violation of the anti-fraud provisions of the federal securities laws in two instances: (1) consummation of the NSMC merger; and (2) the immediately following sale of newly acquired NSMC stock by former Interstate principals, including certain of the defendants. These transactions are alleged to have occurred despite the prior receipt by the defendants of information which revealed that NSMC's interim financial statements, used in securing shareholder approval of the merger and available to the investing public generally, were grossly inaccurate and failed to show the true condition of the corporation. The information was included in a comfort letter prepared by NSMC's accounts. The Commission contends that these violations demonstrate a reasonable likelihood of future misconduct by the defendants, thereby justifying the requested permanent injunctive relief.

 The matter was tried without a jury. After reviewing the extensive record in this case, the Court concludes, for the reasons stated below, that while each of the defendants violated the securities laws in specific instances, the Commission has not fulfilled its obligation of demonstrating a reasonable likelihood that they will do so in the future. Accordingly, the Commission's request for injunctive relief must be denied.

 This opinion contains the findings of fact and conclusions of law required by Rule 52 of the Federal Rules of Civil Procedure. Initially it will present the background events of this proceeding, including details of the October 31 merger of Interstate and NSMC, and the stock sales by Interstate principals. The Court then will review the Commission's allegations against the defendants in light of the applicable legal principles. Finally, the Court will address the factors involved in its determination that injunctive relief is not warranted in this instance.


 A. The Companies

 National Student Marketing Corporation was incorporated in the District of Columbia in 1966. The company enjoyed early prosperity; it grew rapidly and experienced a steady increase in assets, sales and earnings. Its common stock, which was registered with the SEC and traded on the over-the-counter market, rose from an initial public offering of $ 6 per share in the spring of 1968 to a high of $ 144 per share in mid-December 1969. *fn3" The financial community held the company and its potential in high regard, and in anticipation of continued high market performance, it was seen as a good "buy" prospect. Its management was considered aggressive, imaginative and capable; if there was a question of its integrity and honesty, it did not surface in the public arena until a later period. During this period, White & Case served as its outside legal counsel, with Marion J. Epley, III, as the partner immediately in charge of the firm's representation. Peat Marwick served as its outside accountant.

 Interstate National Corporation, a Nevada corporation, was an insurance holding company. Its principal assets were several wholly-owned subsidiary insurance companies. The company's common stock was traded on the over-the-counter market and owned by approximately 1200 shareholders. Cameron Brown was president, chief executive officer, principal shareholder and a director of the company. *fn4" Other Interstate principals and directors included Robert P. Tate, chairman of the board; William J. Bach, general counsel; Paul E. Allison, secretary; Louis W. Biegler; and Max E. Meyer. Between board meetings, all management authority was delegated to an executive committee composed of Brown, Tate, Bach, Allison and Biegler. Max E. Meyer, a director and shareholder, was a partner in the Chicago law firm of Lord, Bissell & Brook, which had long represented Interstate and served as its outside legal counsel in all matters relating to the merger of the corporation with NSMC. Meyer, a personal friend and legal advisor to Cameron Brown, served as the contact partner for the Interstate account and was otherwise in overall charge of his firm's representation. *fn5" Another partner of the firm, Louis F. Schauer, was also involved in the merger transaction due to his experience in corporate and securities law. Peat Marwick served as Interstate's outside accountant during the period in question.

 B. The Merger Negotiations

 National Student Marketing Corporation developed a reputation for having a unique and successful marketing network for selling its own and other products to college and high school students. Commencing in 1969, it undertook a highly active program to acquire companies specializing in selling goods and services to students. It was in this connection that NSMC first approached representatives of Interstate.

 Initially, NSMC discussed the possibility of acquiring an Interstate subsidiary that specialized in selling insurance to students. After Interstate indicated an unwillingness to dispose of a single subsidiary, NSMC expressed interest in acquiring its entire insurance holding company operation. Cortes W. Randell, NSMC's president and chief executive officer, proposed a merger of the two corporations, offering one share of NSMC stock for every two shares of Interstate stock.

 On June 10, 1969, NSMC representatives, including Randell and James F. Joy, a senior vice president and finance committee member, were invited before the Interstate directors to make a presentation concerning the proposed merger. The directors were provided with NSMC's 1968 annual report and its financial report for the first half of 1969. Randell discussed the company's acquisition program, reviewed several pending corporate acquisition commitments, and made certain earnings predictions for the fiscal year ending August 31, 1969. He also increased the earlier offer to two shares of NSMC common for every three shares of Interstate common. When certain Interstate directors expressed a desire to sell a portion of the NSMC stock which they expected to acquire in the merger, Randell responded that a registered public offering was planned for the fall of 1969, at which time the former Interstate shareholders could sell up to 25 percent of their shares. *fn6" Very few questions were asked by Randell or Joy about the business and financial affairs of Interstate, an aspect of the meeting which surprised several of Interstate's representatives.

 This meeting resulted in an agreement in principle for the merger. Essentially identical press releases were then issued by the companies, announcing the agreed upon stock exchange ratio, the estimated value of the transaction as $ 37 million based on the current market value of NSMC stock, and the fact that the transaction represented approximately a 100 percent premium for the Interstate shares based on their market value at the time. *fn7" Representations were also made in the releases as to NSMC's earnings for the first six months of fiscal 1969, which ended February 28, 1969.

 The two corporations' efforts to finalize the merger agreement were not uneventful. The initial proof of the Merger Agreement, prepared by NSMC's outside counsel, failed to provide for parallel rights and obligations of the parties. In fact, as to such matters as warranties and representations, a comfort letter from independent accountants, and counsel opinion letters on legal aspects of the merger, far more was required of Interstate than of NSMC. After insistence by Interstate, however, there was agreement to substantially parallel and mutual provisions covering those matters. On August 12, the Interstate directors met to review the final version of the agreement. A copy of a report from White, Weld & Co. (White Weld), a stock brokerage and investment consultant firm retained by Interstate to prepare an in-depth study of NSMC and the proposed merger, was made available to each director. A White Weld representative explained various aspects of the report, answered questions about NSMC's accounting procedures, and recommended the merger. Following that presentation, Louis F. Schauer, who had broad experience in corporate and securities law, reviewed and explained the agreement. A proof copy of the NSMC proxy statement was also available and examined by the directors then present. Although prepared for use in connection with the merger, that statement contained no entries in the spaces for NSMC's unaudited consolidated income statement for the nine-month period ending May 31, 1969. Because of the omission, Interstate's board chairman, Tate, refused to sign the agreement. After numerous efforts at attempting to obtain the missing proxy statement data and satisfactory answers to questions concerning the omitted data, the information was finally received by telephone. The remaining directors, including Tate, then signed the merger agreement on August 15. The added information, however, was not then analyzed or reviewed to any extent by any Interstate representative.

 The Merger Agreement set forth fully the terms and conditions of the understanding between the two corporations. Among other things, both corporations represented and warranted that the information "contained in Interstate's and NSMC's Proxy Statements relating to the transactions contemplated by this Agreement will be accurate and correct and will not omit to state a material fact necessary to make such information not misleading," *fn8" and that the financial statements included among the provisions "are true and correct and have been prepared in accordance with generally accepted accounting principles consistently followed throughout the periods involved." *fn9" NSMC specifically referred to its 1968 year-end and May 31, 1969, nine-month financial statements and represented that those statements:

fairly present the results of the operations of NSMC and its subsidiaries for the periods indicated, subject in the case of the nine month statements to year-end audit adjustments. *fn10"
The Agreement also provided several conditions precedent to the obligations of the two corporations to consummate the merger. One required the receipt by NSMC of an opinion letter from Interstate's counsel LBB to the effect, Inter alia, that Interstate had taken all actions and procedures required of it by law and that all transactions in connection with the merger had been duly and validly taken, to the best knowledge of counsel, in full compliance with applicable law; a similar opinion letter was required to be delivered from NSMC's counsel to Interstate. *fn11" Another condition was the receipt by each company of a "comfort letter" from the other's independent public accountants. Each letter was required to state: (1) that the accountants had no reason to believe that the unaudited interim financial statements for the company in question were not prepared in accordance with accounting principles and practices consistent with those used in the previous year-end audited financials; (2) that they had no reason to believe that any material adjustments in those financials were required in order fairly to present the results of operations of the company; and (3) that the company had experienced no material adverse change in its financial position or results of operations from the period covered by its interim financial statement up to five business days prior to the effective date of the merger. *fn12" Although setting forth these specific conditions to consummation of the merger, the final paragraph of the Agreement also provided that:
Anything herein to the contrary notwithstanding and notwithstanding any stockholder vote of approval of this Agreement and the merger provided herein, this Agreement may be terminated and abandoned by mutual consent of the Boards of Directors of NSMC and Interstate at any time prior to the Effective Date and the Board of Directors of any party may waive any of the conditions to the obligations of such party under this Agreement. *fn13"
Finally, the Agreement specified that "(t)he transactions contemplated herein shall have been consummated on or before November 28, 1969." *fn14"
Both NSMC and Interstate utilized proxy statements and notices of special stockholder meetings to secure shareholder approval of the proposed merger. Interstate's materials included a copy of the Merger Agreement and NSMC's Proxy Statement; the latter contained NSMC's financial statements for the fiscal year ended August 31, 1968, and the nine-month interim financial statement for the period ending May 31, 1969. Interstate shareholders were urged to study the NSMC Proxy Statement:
The NSMC Proxy Statement contains a description of each company, relevant financial statements, comparative per share data and other information important to your consideration of the proposed merger. You are urged to study the NSMC Proxy Statement, hereby incorporated as part of this Proxy Statement, prior to voting your shares. *fn15"
In mid-October, Peat Marwick began drafting the comfort letter concerning NSMC's unaudited interim financials for the nine-month period ended May 31, 1969. As issued by NSMC, those financials had reflected a profit of approximately $ 700,000.
Soon after beginning work on the comfort letter, Peat Marwick representatives determined that certain adjustments were required with respect to the interim financials. Specifically, the accountants proposed that a $ 500,000 adjustment to deferred costs, a $ 300,000 write-off of unbilled receivables, and an $ 84,000 adjustment to paid-in capital be made retroactive to May 31 and be reflected in the comfort letter delivered to Interstate. Such adjustments would have caused NSMC to show a loss for the nine-month period ended May 31, 1969, and the company as it existed on May 31 would have broken even for fiscal 1969. Although Peat Marwick discussed the proposed adjustments with representatives of NSMC, neither the accountants nor NSMC informed Interstate of the adjustments prior to the closing. *fn17" A draft of the comfort letter, with the adjustments, was completed on October 30 and on the next day, the morning of the closing, it was discussed among senior partners of Peat Marwick.
C. The Closing and Receipt of the Comfort Letter
The closing meeting for the merger was scheduled at 2 p.m. on Friday, October 31, at the New York offices of White & Case. Brown, Meyer and Schauer were present in addition to Interstate directors Bach, Allison and Tate. The representatives of NSMC included Randell, Joy, John G. Davies, their attorney Epley and other White & Case associates.
Although Schauer had had an opportunity to review most of the merger documents at White & Case on the previous day, the comfort letter had not been delivered. When he arrived at White & Case on the morning of the merger, the letter was still not available, but he was informed by a representative of the firm that it was expected to arrive at any moment.
The meeting proceeded. When the letter had not arrived by approximately 2:15 p.m., Epley telephoned Peat Marwick's Washington office to inquire about it. Anthony M. Natelli, the partner in charge, thereupon dictated to Epley's secretary a letter which provided in part:
(N)othing has come to our attention which caused us to believe that:
1. The National Student Marketing Corporation's unaudited consolidated financial statements as of and for the nine months ended May 31, 1969:
a. Were not prepared in accordance with accounting principles and practices consistent in all material respects with those followed in the preparation of the audited consolidated financial statements which are covered by our report dated November 14, 1968;
1. In adjusting the amortization of deferred costs at May 31, 1969, to eliminate therefrom all costs for programs substantially completed or which commenced 12 months or more prior, an adjustment of $ 500,000 was required. Upon analysis of the retroactive effect of this adjustment, it appears that the entire amount could be determined applicable to the period prior to May 31, 1969.
2. In August 1969 management wrote off receivables in amounts of $ 300,000. It appears that the uncollectibility of these receivables could have been determined at May 31, 1969 and such charge off should have been reflected as of that date.
3. Acquisition costs in the amount of $ 84,000 for proposed acquisitions which the Company decided not to pursue were transferred from additional paid-in capital to general and administrative expenses. In our opinion, these should have been so transferred as of May 31, 1969.
2. During the period from May 31, 1969 to October 28, 1969 there has been no material adverse change in the consolidated financial position of National Student Marketing Corporation and its consolidated subsidiaries, or any material adverse change in results of operations of National Student Marketing Corporation and its consolidated subsidiaries as compared with the nine month period ended May 31, 1969 after giving retroactive effect at May 31, 1969 of the adjustments disclosed above. *fn18"
Schauer was the first to read the unsigned letter. He then handed it to Cameron Brown, advising him to read it. Although there is some dispute as to which of the Interstate representatives actually read the letter, at least Brown and Meyer did so after Schauer. They asked Randell and Joy a number of questions relating to the nature and effect of the adjustments. The NSMC officers gave assurances that the adjustments would have no significant effect on the predicted year-end earnings of NSMC and that a substantial portion of the $ 500,000 adjustments to deferred costs would be recovered. Moreover, they indicated that NSMC's year-end audit for fiscal 1969 had been completed by Peat Marwick, would be published in a couple of weeks, and would demonstrate that NSMC itself had made each of the adjustments for its fourth quarter. The comfort letter, they explained, simply determined that those adjustments should be reflected in the third quarter ended May 31, 1969, rather than the final quarter of NSMC's fiscal year. Randell and Joy indicated that while NSMC disagreed with what they felt was a tightening up of its accounting practices, everything requested by Peat Marwick to "clean up" its books had been undertaken.18A
At the conclusion of this discussion, certain of the Interstate representatives, including at least Brown, Schauer and Meyer, conferred privately to consider their alternatives in light of the apparent nonconformity of the comfort letter with the requirements of the Merger Agreement. *fn19" Although they considered the letter a serious matter and the adjustments as significant and important, they were nonetheless under some pressure to determine a course of action promptly since there was a 4 p.m. filing deadline if the closing were to be consummated as scheduled on October 31. *fn20" Among the alternatives considered were: (1) ...

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